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Court Holds that Lender Can Sue Borrower for Deficiency on Loan Following 2010 Short Sale

In Bank of America, N.A. v. Roberts, a California Appellate Court held that in the circumstances presented in the case, Bank of America could pursue the defendant borrower for the deficiency on the borrower’s home equity loan. 
 
The borrower obtained a home equity loan from Bank of America.  The loan was secured by a second deed of trust on the borrower’s property.  Following a default on the defendant’s first loan, to avoid a foreclosure, the defendant opted to sell the property pursuant to a short sale.  In 2009, Bank of America consented to the short sale, but reserved its right to pursue the defendant for the deficiency on the home equity loan.  In 2010, following the short sale, Bank of America filed a complaint against the defendant for breach of contract and common counts, arising out of the defendant’s failure to repay the home equity loan.  Bank of America then filed a motion for summary judgment.  The defendant opposed the motion.  Although she admitted that she defaulted on the loan, the defendant argued that the bank was barred from seeking the deficiency based on Civil Procedure sections 580e and 726.  The trial court granted the motion and entered judgment in favor of the bank.  The defendant appealed.
 
The defendant raised two primary arguments on appeal.  She first argued that Section 580e, which acts to bar deficiencies following short sales in specified circumstances and which was amended as of July 2011 to apply to junior loans, should apply retroactively.  The court disagreed.  The court explained that statutes generally do not apply retroactively and that there was nothing in the language of Section 580e, as amended to include junior loans, that would allow for retroactive application.  The court also noted that it would be unfair to the bank to change the legal consequences of its agreement with the defendant in a retroactive manner. 
 
The defendant next argued the Section 726 barred the bank’s recovery of the deficiency.  She argued that under this section, judicial foreclosure was the only form of action allowable for collecting on a debt secured by real estate and that because the bank did not foreclose, it was barred from obtaining a deficiency judgment.  Bank of America argued that because of the short sale, section 726 was not applicable. 
 
Section 726 states that “there can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property...”  The “one form of action” is a foreclosure action, in which the creditor must first exhaust the security before seeking a money judgment for the deficiency.  The court found that by asking for the bank’s consent to the short sale, which she received, the defendant waived any rights she may have had under Section 726.  The short sale did not result in a multiplicity of actions as the short sale was not an “action” and the bank did not file an action until the defendant defaulted on the home equity loan.  In addition, because the lenders released their liens on the property, which then sold, the security was “exhausted” before the lender filed suit. 
 
The defendant also tried to raise an argument that the Troubled Asset Relief Program (“TARP”) somehow prevented the bank from recovering the deficiency.  The court rejected this argument on several grounds, including that it was raised for the first time on appeal.  The court also noted that TARP did not create a private right of action.

Finally, the defendant argued that the trial court should have applied a defense of unclean hands.  She stated that the bank became aware of the defendant’s financial hardship during the short sale process and must have unfairly coerced her to enter the short sale arrangement.  The appellate court noted that there was nothing prejudicial to the defendant or problematic in the terms of the short sale, and thus declined to apply the doctrine of unclean hands.
 
The court affirmed the judgment in favor of the bank.

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